No Deductions for Legal Medical Marijuana Dispensary

Here’s a very interesting article by Attorney James McDonough

August 20, 2015

Last week, the Ninth U.S. Circuit Court of Appeals ruled that medical marijuana dispensaries cannot claim business expenses to the IRS as other commercial enterprises.

According to Forbes, the decision is considered a financial setback for medical marijuana dispensaries because, with business deductions being disallowed, they must pay taxes on 100 percent of their gross income. The decision is a blow to dispensaries across the country that have flourished in states that voted to legalize the use of medicinal marijuana.

The decision

In the case of Olive V. Comm., the Ninth Circuit upheld the federal tax law to disallow tax deductions despite the legal status of dispensaries in California. According to Judge Susan Graber, the Court affirmed Sec. 280E of the federal tax code that denies deductions for the expenses of “trafficking in controlled substances.” The ruling stated that a medical marijuana dispensary cannot deduct expenses from taxable income because their only commercial product is a controlled substance prohibited by federal law. Despite the various services offered by the taxpayer in the case, the Court ruled that since marijuana sales were the only activity in which the taxpayer engaged in with the “intent of realizing a profit”, it was therefore a “trade or business” involved in trafficking a controlled substance, and thus not eligible for expense deduction.

The case

The case involved Martin Olive, owner and operator of the Vapor Room in San Francisco, who appealed a Tax Court ruling to deny his business expense deductions. In the appeal, Olive argued that Sec. 280E’s use of the phrase “consists of” applied to the Vapor Room because it offered other services in addition to marijuana sales, thereby entitling the enterprise to expense deductions.

However, since these services were free, the Court ruled that all of the $655,000 in business expenses from the Vapor Room between 2004 and 2005 were disallowed. The Court also rejected Olive’s argument that the Vapor Room was entitled to deductions under Californians Helping to Alleviate Medical Problems, Inc. v. Comm, which allowed expense deductions related to sales of counseling and caregiving services. In that earlier case, the court held that section 280E does not preclude petitioner from deducting expenses attributable to a trade or business other than that of illegal trafficking in controlled substances simply because petitioner also is involved in the trafficking in a controlled substance. Judge Graber stated that the Vapor Room could not deduct any such expenses because the business did not charge for those services, and marijuana sales are not considered counseling and caregiving services.

Room for optimism

Although the ruling bans tax deductions for enterprises with marijuana sales as their sole source of revenue, dispensaries are eligible for standard business expense deductions for additional products for sale. In an interview with the SF Gate, Olive’s lawyer Henry Wykowski noted that medical marijuana dispensaries can claim expenses from sales of other commercial products, including food and services. The difficulty will be apportioning business expenses between the permissible activities and the impermissible activity

“The decision will benefit dispensaries that sell a variety of products including those that are not cannabis,” explained Wykowski. “I don’t think it’s a blow to the industry at all.” However, the decision was not a “win.”

A recent ABA Journal article reported on the application by a marijuana trade group for a Colorado state credit union charter because banks were unwilling to accept cash deposits from dispensaries. It will be interesting to learn if that application is granted.